Asness and Brown have hockey lessons for money managers

In hockey, “pulling the goalie” is considered a risky and dramatic move – by removing the goalie and adding a forward to boost the chance of scoring a goal, a team ends up with no one watching the net.

But is that such a bad strategy? In a new paper, Clifford Asness and Aaron Brown argue that coaches should be pulling the goalie more frequently – and that their unwillingness to do so reflects the dilemma faced by many investment managers when it comes to balancing risks and return.

The authors start off by building a quite helpful model for when a hockey coach should pull the goalie when a team is trailing in points. According to their findings, coaches should be using this strategy a lot more often.

Asness and Brown then posit the reasons why coaches don’t pull the goalie more often and apply them to investment managers and their own unwillingness to try new strategies and take more risks.

A few key findings:

First, while pulling the goalie is often used as a metaphor for a high-risk desperation move, it actually means that the coach is focused on the right thing – maximizing the number of standing points before the game is over. Hence, by not taking action to gain more goals (pulling the goalie) and instead focusing on protecting the net, coaches are creating a new risk – the risk of not getting enough goals to win the game.

There’s a direct parallel with investors:

“Investors sometimes make similar mistakes when they focus on the risk of an investment, rather than the risk an investment adds to their overall portfolio. If increased portfolio volatility comes with sufficient extra excess expected return, over long periods of time a portfolio can have a better chance of an acceptable return by taking more short -term volatility.

Asness and Brown also note that both coaches and investment managers worry a good deal about reputational risk – being perceived as prudent and running a tight ship is important, especially in the face of a loss. But what about the potential for adding returns? Here the authors evoke Keynes – it’s more important to fail conventionally than to succeed unconventionally — and apply it to both hockey and investing.

Hockey fans will enjoy Asness and Brown’s pull the goalie model – and investment managers might enjoy a new way of looking at the risk-return relationship.